How to Get Started in Chart Reading

Even master technicians had simple beginnings, and these insights and
real market examples are intended to help beginners develop the skills to
analyze charts and spot opportunities in the markets.

Over 30 years ago, when I started studying stock charts, I worked exclusively
from printed chart books from either Mansfield or Daily Graphs, both of whom are still printing charts.

The leading book on technical analysis at the time was Technical Analysis
of Stock Trends, byEdwards and Magee. My learning curve
consisted of reviewing literally thousands of charts in the early years, drawing
multiple trend lines, and then observing what happened.

Chart analysis can be fairly subjective, and I have often been asked during
seminars "Why did you use this trend line instead of another one?" Therefore, I
thought that an explanation of how and why I draw trend lines might be helpful
to beginning chartists, as well as provide the more experienced chart readers
with some additional perspective.

First of all, it should be noted that in preparing charts for my regular
articles, I often start out with a series of trend lines, but only include one
or two in the published chart. I realized early on that it was often better if I
did not know much, if anything, about the company when doing my analysis,
because that kept me more objective. Therefore, in the first few examples, I
will not reveal either the company name or the time period I am reviewing.

Figure 1

Click to Enlarge

This daily chart allows me to share some examples of the key guidelines that
I follow when analyzing a market. The first guideline is that time is important.
The longer it takes to develop a trend line or area of support or resistance,
the more important that level is to the market's trend.

The second guideline is that the greater the number of points that can be
used to identify an important support or resistance level, the more likely it is
that prices will respect that level. The uptrend, line b, is drawn using the
February, March, and April lows. The low in May was $15.13, which was
comfortably above the trend line at $14.96. The low in September held just a few
cents above this support.

A common mistake I notice when working with some short-term traders is that
they use a five-, 15-, and 60-minute chart, and though they may have a daily
chart on their screen, it is not studied as rigorously as the other time
periods. When this is pointed out, the answer is that they were just looking for
set-ups on the 15- and 60-minute charts. The problem with that is sometimes an
intraday set-up will come at an important level on the daily chart that limits
its chance of success.

From the June and July highs, one was able to identify a level of resistance,
line a, that was also tested in August and approached in early September. The
stock then dropped sharply to test the uptrend, but held above the June lows,
which was a reason to stay positive on the stock.

Though the breakout was accompanied by better-than-average volume, it was
less than what was observed on the prior decline. Ideally, this is not what one
wants to see. Nevertheless, prices held above the breakout level for the
following two days, suggesting the uptrend had resumed.

The stock made a series of higher lows and higher highs over the next few
months, but the short-term uptrend that might have been derived from those lows
was violated on the drop in November. This was then a good focal point for a new
uptrend (line c).

Prices held above this support (line d) until early February, as the daily
chart developed a pattern of lower highs and lower lows. This made the
short-term trend negative, but as long as the long-term support (line b) held,
the intermediate trend remained positive.

NEXT: Spot Key Trends on the Weekly Chart

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Figure 2

Click to Enlarge

This weekly chart is of the same stock and starts just as prices had broken
through the resistance from the previously discussed February highs at $21.46.
On the weekly chart, I have drawn an uptrend from the low in September at the
far right and the April low, giving me line a.

By late May, the stock was again making new highs and peaked in July before
undergoing a sharp setback in August. It was then possible to draw a steeper
uptrend, line b, using the April and August lows. This support held until August
of the following year, point 1.

The stock attempted to stabilize after closing below this weekly support but
then continued lower for the next nine weeks, which confirmed that the uptrend
was important. The stock lost another 18% after the weekly close below line
b.

The longer-term uptrend, line a, did hold on this decline. Just eight weeks
after the lows (point 2), the stock had made new rally highs, signaling that a
new uptrend was underway. The stock moved sideways early the next year, making a
series of successively minor lows. In April, it dropped to $54.45 early in one
week, but then reversed to close at $63.78, above the highs of the prior ten
weeks.

This type of action is generally quite significant, and a new uptrend, line
c, was drawn using this low. Further new highs were made in July at $72.28
before a correction took prices back to the support at line c. The stock's
failure to make new highs on the next rally was an early sign of weakness. The
uptrend was broken a few weeks later (see circle), but the weekly close was
above the uptrend.

I have found that it is a close above or below an uptrend or downtrend that
is more significant than if the trend line is broken during the week. If a
weekly uptrend is broken during the week, it can often be an early warning sign,
and I then try to monitor the action more closely.

The stock made a marginal new high at $75.37 in October, then moved sideways
for several weeks before gapping (point 3) through the support at line c. Gaps
above or below weekly trend lines are almost always significant and demand that
one either close out their position or use very tight stops.

Both the August and October lows were violated the following week, suggesting
that a pattern of lower lows and lower highs was developing. Confirmation of a
change in trend came several weeks later when the long-term uptrend, line a, was
broken (point 4). The stock accelerated to the downside, eventually reaching
$40.36 in early March (point 5).

From this low and the July-to-September lows, a new uptrend, line d, could be
drawn, but this was no longer a bullish chart. This support was more important
for those who wanted to trade a further decline because a top was already in
place.

The stock made it all the way back to $71.21 by December, which allowed those
who stubbornly stuck with their long positions to get out. The reversal from
these highs and the break of support at point 6 indicated a resumption of the
downtrend. Using this high, it was possible to draw a new downtrend, line e,
which is still intact ten years later.

NEXT: Discover the Identity of This Mystery Stock

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Figure 3

Click to Enlarge

I purposely left out the name and date range for the stock in Figures 1 and 2
since I was trying to point out the importance of being objective with your
chart analysis. The stock in both charts was Bristol-Myers
Squibb (BMY). Figure 1 covers the period from February 1995 through
June 1996, while the weekly chart covered the period from March 1996 until June
2001.

I did not want to influence your chart reading by calling up any memories you
might have of the bull market top in 2001. The downtrend, line e, from Figure 1,
is still intact and is now at $30.86. It is labeled as line a on the current
weekly chart.

BMY has developed an up-trending channel from the 2009 lows, lines c and d.
If the major downtrend is surpassed, there is also significant resistance at
$34.70, line b. A break of support at $24.30 (line d) will suggest another leg
to the downside for BMY.

Apple Inc. (AAPL) is clearly a market bellwether, which makes it an
important stock to keep an eye on even if you are not trading it. The 2009 and
2010 lows allow us to draw a long-term uptrend, line f, as well as an upper
trading channel, line e. I find trading channels can be very useful, as often
times, stocks will test the upper boundaries of the trading channel, which will
also correspond to the weekly Starc+ band, indentifying a potential turning
point.

AAPL surpassed both the weekly Starc+ band and line e during the week ending
July 30 when it surged to a high of $404.50. Since this high was significantly
above the prior high at $360 in February, there are no signs that the powerful
uptrend is weakening.

The stock also held the uptrend (line e) in June with the low at $310.50
(line g). This now becomes the first key level of support to watch. If it is
broken, the focus will turn to the support from the 2010 highs at $280.

Figure 4

Click to Enlarge

Amazon.com (AMZN) is another stock that has led the market on the upside
since the 2009 lows. The primary uptrend, line c, was clear in September 2010,
as it was drawn from the late-2008 and the July 2010 lows. This allowed one to
draw an upper parallel trading channel, line a, from the December 2001 high at
$145.91.

The upper channel acted as strong resistance in January and May 2011. It was
surpassed in August 2011 as AMZN surged to a high of $227.45. The decline from
this high has been quite sharp, as the shorter-term uptrend, line b, was broken
on a closing basis the week ending August 19. The June lows at $181.59 have also
been broken.

This makes the mid-March lows at $160.59 a pivotal level to watch. A look at
the daily chart of AMZN (not shown) indicates that it will take a close above
the $205.60 level to stabilize the weekly chart.

NetFlix Inc. (NFLX) has also been a powerful performer, and since the
November 2008 lows at $17.90, the stock rose to a high of $304.79 in 2011. The
long-term support from the lows, line f, is well below the market at $88.40.

The steep uptrend, line d, was drawn from the July 2010 and the March 2011
lows. It was broken on a closing basis the week ending July 30. It is also a
concern that the multiple weekly lows from April 2011 at $224 have been broken,
as NFLX made a recent low of $205.

The nearby uptrend, line e, is derived from the January 2010 and July 2010
lows and is currently at $194. If this support and the March low at $188.89 are
violated, a decline to the $150 area becomes likely. NFLX needs a weekly close
above the $250 level to avoid a decline to the support in the $150 area.

NEXT: Tom's Updates for 2012

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2012 Updates

This article was originally released on August 25, 2011, but the basic
concepts of chart reading are applicable to the charts of tomorrow as well as
historical charts.

Since I am out this week, I thought it might be interesting to update the
charts of Bristol-Myers Squibb (BMY), Apple (AAPL), Amazon.com (AMZN) and NetFlix (NFLX) to see if last summer's trend lines were relevant to the
price action since August 2011.

Figure 5

Click to Enlarge

At the time of the original article last August (line 1), the long-term
downtrend for Bristol-Myers Squibb (BMY), line a, was at $30.86. By the middle of September, it
had declined to just above the $30 level. The week ending September 17, it was
overcome with the weekly close at $30.56. By the end of the year, BMY surged as
high as $35.44 and broke out above the trading channel, line c. The resistance
at $34.70, line b, was therefore overcome, and it has provided support in
2012.

In August 2011, the weekly chart of Apple (AAPL) showed a well established trading channel, lines e and
f. In October and November 2011, AAPL came close to its major uptrend, line f.
AAPL hit a low of $363.32 just after Thanksgiving, before accelerating to the
upside. It held well above the important level of support at $302 that was
identified last August.

The upper channel was overcome in early February, as AAPL shot to a high of
$644 in April. The pullback from the highs dropped AAPL back to $522, which was
well above the channel support, line e, which is now at $502.

Figure 6

Click to Enlarge

Amazon.com (AMZN) had broken the uptrend, line b, as the original article
was released (line 1). This made the March 2011 low at $160.59 the key level to
watch, and AMZN held well above it, as it made a low of $177.55. AMZN rallied
sharply from these lows, moving well above the upper trading channel, line a,
and reached a high of $246.71 in October.

The correction from these highs was quite sharp, as AMZN dropped 30% from the
highs and tested the long-term uptrend, line c. The late December low at $166.97
is now the important level to watch. The weekly chart for AMZN now shows a clear
uptrend, with next resistance at $233.84, which was the May high.

Lastly we have NetFlix (NFLX), which was one of the big stock stories of 2011. At the
end of July 2011, the steepest of its weekly trend lines, line d, was broken.
Just over a month after the original article release (line 1), the further
support in the $194 area, line e, was also violated.

The next level of support at $150 provided little support, as NFLX continued
to crash-losing 69% in just eleven weeks. The next support at $150 was quickly
broken, as was the long-term support at line f. NFLX eventually hit a low of
$62.37 in December 2011. The February high at $133.43 now must be overcome to
complete the potential double-bottom formation.

ConclusionI hope you have found this introduction to
chart reading helpful, and that it may have changed your approach to chart
analysis. I would suggest that new chartists begin with the weekly chart and
draw multiple lines before deciding which ones are the most important. Then, try
to isolate either uptrends or downtrends that are derived from more than two
points. Only after you have completed your weekly analysis should you go to the
daily charts to determine whether the two time periods are in agreement.

Once you have gone through many charts, review them later to see if the
levels you identified were indeed important. At that point, you might want to
consider adding relative performance, or RS analysis, or on-balance volume (OBV) analysis to see if it helps you get a
better idea of a market's direction.

Experienced traders, consider printing out weekly charts of the market(s) you
are trading and then use a ruler to analyze the charts. It's possible that this
will give a different perspective than drawing trend lines by
computer.